On Sept. 6, 2011, the Securities and Exchange Commission (“SEC”) announced that it would not seek rehearing of the ruling of the Court of Appeals for the D.C. Circuit vacating Rule 14a-11, the SEC’s universal proxy access rule. Rule 14a-11, which was mandated by Dodd-Frank, would have enabled shareholders that satisfied both a three-year holding period and three-percent ownership threshold to include director nominees in the company’s proxy materials.
The Demise of Universal Access
Within a matter of days after Rule 14a-11 was adopted, the Business Roundtable and the U.S. Chamber of Commerce brought suit seeking to have the rule vacated. Pending the outcome of the case, in addition to staying the effectiveness of Rule 14a-11, the SEC voluntarily stayed the effectiveness of amendments to Rule 14a-8 that would, under most circumstances, no longer enable companies to exclude from their proxy materials proxy access proposals submitted by shareholders.
Earlier this summer, the court vacated Rule 14a-11 in a decision that was highly critical of the SEC. The court concluded that the SEC had violated the Administrative Procedure Act by arbitrarily and capriciously failing to adequately assess the economic impact of Rule 14a-11. According to the court, the SEC inconsistently and opportunistically framed the costs and benefits of the rule, failed to adequately quantify the costs of the rule or explain why they could not be quantified, failed to support its predictive judgments, contradicted itself and failed to respond to substantial problems raised in comments to the rule.
Neither the court’s decision in the case nor the SEC’s decision not to seek a rehearing preclude the SEC from re-proposing universal proxy access. The court’s decision was limited to the procedural defects of the rule-making process and did not address the constitutionality of universal proxy access. However, the SEC is not likely to re-propose universal proxy access any time soon given the significant procedural defects cited by the court and the substantial number of Dodd-Frank and other initiatives on its plate, as well as political considerations.
The Rise of Private Ordering
The proxy access lawsuit did not challenge the amendments to Rule 14a-8. By its terms, the SEC’s stay order pertaining to those amendments expires automatically when the court’s decision is finalized, which is expected to occur on Sept. 13, 2011. Therefore, absent further SEC action, the amendments to Rule 14a-8 will take effect and a notice of the effective date of the amendments will be published by the SEC.
Following the effectiveness of the amendments to Rule 14a-8, through what is known as “private ordering,” a shareholder will be able to submit for inclusion in a company’s proxy materials, to then be voted on by the shareholders, a proposal to amend the company’s charter or bylaws to provide for proxy access or that requests the board to implement proxy access. The quantitative thresholds for submitting a Rule 14a-8 proposal are low — the proposing shareholder is only required to continuously hold $2,000 of the subject company’s voting securities for one year prior to submitting the proposal — and otherwise there are limited grounds for rejecting the proposal. As a practical matter, the holding period and ownership requirements of Rule 14a-8 do not act as even a modest speed bump, since there is a cottage industry of governance activists that actively seek out target company shareholders on whose behalf they can submit Rule 14a-8 proposals.
Unlike Rule 14a-11, which had a phase-in period for smaller companies, the amendments to Rule 14a-8 will take effect for all issuers, including smaller reporting companies, at the same time.
Private Ordering Access Proposals in 2012
Assuming no further delay in the effectiveness of the amendments to Rule 14a-8, predictions vary greatly on the volume of access proposals that will be submitted during the 2012 annual meeting season. However, there is broad consensus that, at a minimum, companies with widely perceived governance issues are likely recipients. As has been the case with other governance initiatives, it is likely that a fairly small number of mostly larger companies will receive access proposals in 2012, with these types of proposals continuing to be refined and momentum picking up in 2013 and beyond.
A proponent must submit a Rule 14a-8 proposal no later than 120 calendar days before the anniversary of the date on which the company's proxy statement for the prior year’s annual meeting was released to shareholders. Based on the annual meeting calendar, the bulk of the proxy access proposals for the 2012 annual meeting season are likely to be submitted between November 2011 and January 2012.
Access proposals are likely to provide for more liberal access than Rule 14a-11. For example, many labor funds have expressed a preference for a two-year holding period, while some governance activists believe that an ownership threshold substantially lower than three percent is appropriate at larger companies. There is some effort underway to develop an access proposal template, but these efforts are in the early stages.
Both ISS and Glass Lewis will evaluate proxy access proposals on a case-by-case basis. In its evaluation, ISS will take into account the proposed ownership threshold and the proponent’s rationale for the proposal at the targeted company in terms of board and director conduct.